The European Commission's recently published Directive on ...
Evidence on the Alternative Investment Fund Managers Directive (AIFMD)
By Dr Syed Kamall, MEP for London (Conservative)
This submission is the personal evidence of Syed Kamall MEP, the Shadow
Rapporteur on the Alternative Investment Fund Managers Directive (AIFMD). It does
not seek to describe the Directive in detail but to contextualise the background and the
potential impacts of the Directive.
The principal point made in this submission is that this is an unnecessary Directive
which will only serve to limit the growth of the financial services industry in London
and across Europe. Furthermore, the draft directive was drafted in a hurry and there
has been no thorough economic impact assessment. Although this Directive now
looks inevitable, the Council of the European Union and the European Parliament
may be able to amend the Directive significantly in order to limit its regulatory scope.
There has always been a degree of antipathy on the Continent of Europe towards the
way in which the Anglo-Saxon economies buy and sell large numbers of shares in
companies and the consequent frequency in the change of control of companies.
Takeovers by private equity vehicles, because they often result in restructuring of
companies are sometimes portrayed as undermining the European concept of “social
solidarity”, even though such takeovers may save jobs and even create new ones,
especially where the company that was taken over had been performing badly.
It has emerged in the media this summer that as far back as April 2007, before the
credit crunch was widely understood or predicted by most economists, the German
Government favoured coordinated action to regulate hedge funds. 1 Germany was
enjoying a current account surplus and there were significant money flows out of the
country so it had an interest in ensuring that German money was not flowing into
risky financial instruments. At the time they regarded the unregulated hedge funds as
risk- takers; it subsequently turned out that the regulated commercial banks were far
higher leveraged and invested in generally much riskier derivative instruments (often
In 2007, socialist Members of the European Parliament, former Danish Prime
Minister Poul Nyrup Rasmussen and Ieke Van den Burg from the Netherlands
published a report reproving hedge funds, Hedge Funds and Private Equity: A
Critical Analysis. 2 The following year the same MEPs pushed for regulation in an
own-initiative report 3 . Although own-initiative reports from the European Parliament
are not legally binding, they are often foreshadow draft Directives such as the one we
now have before us.
For its part, the European Commission resisted regulating hedge funds for two years.
But politicians in the European Parliament have seized on the credit crunch as reason
to look again at regulating hedge funds and private equity. This is despite there being
scant evidence that either forms of alternative investment were the cause of the credit
crunch. (The commercial banks were far more highly geared than most investment
funds and it was their failure to run themselves properly and the regulatory
authorities’ failure to oversee their risks that resulted in them running into trouble.)
It has proved convenient for elected politicians to play to their electorates by trying to
blame the credit crunch on a few "greedy" individuals investing in hedge funds. The
blame should in fact lie with the politicians, regulators and bankers who were
complicit in allowing credit to be overextended to people who could not afford the
homes they were buying, and who allowed bankers to buy securities the underlying
value of which they knew very little. To its credit, the European Commission has
stated in the preamble to the Directive that "AIFM were not the cause of the crisis" 4 .
80% of Europe's hedge funds managers and 60% of Europe's private equity managers
are located in London. Both the German and French governments, during their
Presidencies of the EU from January - July 2007 and July - December 2008
respectively, encouraged the Commission to work up a draft Directive. The new
Swedish Presidency has been more conciliatory in tone, and there may be significant
amendments made to the text of the Directive before it is passed into law.
Now the draft Directive will pass to the Council and the European Parliament for
consideration under the co-decision procedure. The Commission has indicated that it
hopes the Directive can be adopted by the end of the current year with implementation
by Member States required by the end of 2011.
Scope of the Directive
The Directive on Alternative Investment Fund Managers covers a number of
"alternative" investment funds such as hedge funds, private equity, commodity funds,
real estate and venture capital funds.
Hedge funds and private equity are very different investment vehicles. That they are
clumped together under this draft regulation is odd. Private equity investments tend
to be longer term investments in which the investor takes ownership of all or part of a
company with a plan to sell this share at a profit (usually) within a few years. Hedge
funds, on the other hand, invest in a range of instruments on behalf of people and
organisations such as high net worth individuals, insurance companies and pension
The risks in these types of investments are much the same as those of any other type
of investment. In investment there is always a risk of failure, this is intrinsically how
markets function. Hedge funds may be risky in that often they are managed by
individuals and deal with large sums of money. Most hedge fund managers earn their
profit through management fees which are, in most cases, a percentage of the total
value of the fund. Therefore, hedge fund managers have an incentive to act prudently
in their investments as failure will result in a loss for them as well as the investor.
http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=COM:2009:0207:FIN:EN:PDF (p. 3)
Although performance fees may create the incentive for managers to take unnecessary
risks with investors' assets, high-water marks are often used to discourage this sort of
volatile trading. People who invest in such funds should (and in most cases do) act
prudently when investing and are often looking to "riskier" investments as potentially
producing higher returns for their overall investment portfolio.
Impacts of the Directive
Capital adequacy - The draft Directive's rules on capital requirements are intended as
an insurance that funds can meet investor claims. For AIFMs with significant funds
under management, the 0.02% capital add-on will place severe pressure on their
capital resources. It represents a significant jump from current rules in the UK where
AIFs require enough capital to meet basic payrolls, this frees up capital for more
investment. The new requirements are unnecessary for many funds that use lockup
periods to limit investor withdrawals and this jump in requirements can also cause
barrier to entry to markets for new managers and therefore may hinder competition.
Many Member States of the EU do not currently have capital requirements at all; so
the UK is already ahead of many other Member States in this respect and our capital
requirements have proven sufficient for us in the past.
Leverage - The draft Directive intends to impose limits on the amount of leverage that
managers of alternative investments can employ. I do not believe that the investment
strategies of fund managers should be restricted in this way or that government should
be the judge of risk. Investors know the risks and should pay the consequences and
lose their money if these funds do poorly. (Taxpayer bailouts for failed ventures
should not be an option.)
Disclosure - Managers should not be made to make information about borrowing and
leveraging public. This would discourage competition in the industry. It may be
prudent to see that alternative investment fund managers disclose information on their
assets and risk to relevant authorities in their Member States, and that this information
is not disclosed to the market. Potential investors should research information on risk
Custody - The draft Directive, if implemented in its current form, would make it very
difficult for investment managers to invest in funds that are not domiciled inside the
EU. This would apply to the majority of hedge funds and other investment funds
managed in the UK, as the portfolios themselves are often located in other countries.
We could well face a scenario where hedge funds do not relocate their portfolios into
European credit institutions. My conversations have revealed that fund managers
could instead relocate to Switzerland, Shanghai, Delaware or Dubai. Far from
increasing tax revenue in EU member states, this Directive could reduce it by pushing
fund managers out of the EU altogether.
Unemployment would follow and exodus of the hedge fund industry from London.
The City has already incurred many job losses. The lost jobs in the hedge fund
industry would not return.
It is crucial to remember that investors and fund managers are not the only
beneficiaries of AIFs. Pensioners in Europe could also be affected. Many private
pensions invest with hedge funds. One study 5 shows that this Directive could cost the
European private pension industry €25 million and limit options for pensioners.
Some European Member States' pension industries rely very heavily on AIFs, the
Dutch pension industry for example would be extremely jeopardised under the current
It is also important that such funds retain the ability to takeover and turn around
failing companies in order to save jobs and local communities.
It is also vital that a thorough investigation into other beneficiaries and groups that
depend on AIFs, such as homeowners, charities, and consumers, is prepared before
implementation of the Directive is completed.
We need to be sure that this legislation will not drive investment out of Europe. It
would be wise to study the legislation being considered in other countries, such as the
more measured approach of the Obama administration. The Financial Services
Authority has announced that it will publish a cost analysis of the EU Directive later
this year. The City is only just waking up to the implications of the Directive but I
expect the clamour for it to be amended to grow in the coming months.
08 September 2009
Conservative MEP for London
Shadow Rapporteur on the Alternative Investment Fund Managers Directive
3 Bridle Close
Kingston Upon Thames